Understanding the basics of taxation of corporations is the prerequisite for implementing a well-founded tax structure. Both corporate and business tax must be observed. Other factors concern the beginning and end as well as the extent of tax liability. Needless to say, consideration of the tax bases is also one of the most relevant aspects when examining the basis of taxation of corporations.

1st introduction

Whether shopping for food, celebrating in the club or heating the apartment in winter – everyone pays taxes. Tax revenue is the most important revenue of the state and finances state expenditure in the interest of the general population. This includes transport infrastructure and education. A distinction is made between indirect taxes (e.g. sales tax) and direct taxes (e.g. payroll tax).1 However, not only natural persons are taxable. Companies also have to pay taxes in Germany and thus also contribute to the tax revenue of the state. What taxes companies have to pay and to what extent depends on their legal form. In Germany, there are, among other things, individual companies, partnerships and also corporations.2 Since the taxes payable are costs for a company, this results in minimizing the company’s profit. However, since the main goal of the companies is to maximize the profit as much as possible, one should also inform oneself about the amount of taxation of the individual forms of company when choosing the legal form.3 In this work, the basics of taxation of corporations are examined and presented. Initially, the basic terms “corporations” and “taxes” are defined to ensure the basic understanding. The taxation of limited liability companies will then be examined in detail from breakdown point 3. First of all, general regulations under the law are explained here. After that, the beginning and end of taxation of limited liability companies are carried out. The next sub-item explains how the corporate tax base is calculated. The last breakdown point explains the business tax also payable by corporations.

2. definitions of terms

2.1. Corporations

‘corporations’ are legal entities governed by civil law, which are subject to special rules under both commercial and tax law. 4 Corporations may consist of one or more partners. Even if the company does not engage in commercial activity and acts only as an asset management company or as a freelancer company, the income is regarded as commercial income for tax purposes. The following characteristics regularly apply to corporations:

– they are legally and party-capable,

– The existence of the company does not depend on its members

– Members/partners are usually not directly liable towards company creditors (separation principle)

– Regular foreign organization

– Foundation of the company takes place in several process steps:

Conclusion of a social contract

→ Establishment of statutes by a notary

→ Entry into the responsible commercial register

– Statutory provisions concerning share capital or share capital

– Decision-making by majority vote on the basis of the capital injection

In Germany there are a total of 3 types of corporations:

– Aktiengesellschaften (AG)

– limited partnerships on shares (KGaA)

– Company with limited liability (GmbH) 5

As can be clearly seen in Figure 1, there were a total of 607,364 corporations in Germany in 2019. In total, there were approx. 3.29 million companies subject to tax liability and corporations are the most represented alongside natural persons and sole proprietorships and thus contribute a significant part to the annual tax revenues of the state.

Figure 1: Number of taxable companies in Germany 2019

Source 1: Federal Statistical Office, Number of Taxpayers in Germany, 2021

2.2 Taxes

A legal definition of the term “taxes” can be found in the tax code. It defines this as follows: ‘taxes’ are cash benefits which do not constitute consideration for a particular service and are imposed by a public-law community for the purpose of generating revenue on all those who are subject to the facts to which the obligation to provide services is bound by law; the generation of revenue can be ancillary purpose, § 3 para. 1 AO. In Germany, you can differentiate a total of almost 40 tax types. The performance principle should contribute to tax fairness: those who earn the most should contribute relatively more to the community through income tax increases.6 The annually published tax spiral of the Federal Ministry of Finance (see Figure 2) provides a good overview of how the tax revenues of the federal government, the states, the municipalities and the EU are compiled. It is clear that most of the revenue is generated by VAT. However, the corporation tax, which will be the subject of this work, also contributes its share to the tax revenue.

Figure 2: Tax spiral Germany 2020

Source 2: Federal Ministry of Finance, Tax Spiral, 2020, https://www.bundesfinanzministerium.de/Content/DE/Bilderstrecken/Infographics/Infographics-Tax-General/2020-09-15- Steuerspirale.jpg? blob=poster&v=10 accessed on 21.08.2021

Depending on the tax collected, a part is attributed to the federal government, the federal states and the individual municipalities, as can be seen well in Figure 3. The tax revenues of the corporate tax are, for example, half of the federal government and the other half of the federal state.

Figure 3: Distribution of tax revenue in Germany

Source 3: Federal Ministry of Finance, tax revenue distribution, 2018, https://www.bundesfinanzministerium.de/Content/DE/Standard articles/Topics/Taxes/Further Information/Tax.html accessed on 21.08.2021

Taxation of limited liability companies

Both the joint stock company and the limited partnerships on shares and the limited liability company must tax their income or profit. Since corporations are legal entities, they are liable to corporate tax.7 In 2020 alone, the corporation tax raised 12,134 million euros. It therefore contributes a considerable part to the federal tax budget.

Figure 4: Tax revenue by individual tax types 2020

Source 4: Statista, Tax Revenue in Germany, 2020, p. 18.

3.1. General provisions

“Corporation tax is the income tax of corporations.”8 The Corporate Income Tax Act distinguishes between limited and unlimited tax liability.9 Corporations with registered office or management in Germany are subject to unlimited corporate tax, § 1 para. 1 KStG. This tax liability concerns all income of corporations, § 1 para. 2 KStG. The Income Tax Act and the Corporate Tax Act determine what is to be called income and how the investigation takes place.10 In the case of commercial enterprises, the achievement of profits and participation in trade is not decisive for tax liability, § 4 KStG. If the companies to be taxed are unlimited taxable, e.g. B. Corporations, all income is treated as income from business operations, § 8 para. 2 KStG. In principle, corporation tax constitutes an annual tax and is usually to be determined for a calendar year, § 7 para. 3 p. 1 f. KStG. There are exceptions for companies that are obliged to keep accounts in accordance with the Commercial Code. In these cases, the tax is calculated for a marketing year, § 7 Abs. 4 p. 1 KStG. The principle of separation applies to the taxation of limited liability companies. This means that the corporation and the shareholder are strictly separated from each other and the corporation is the tax subject. The personal taxation of shareholders is not affected by this. They only have to tax their income on distribution. However, there is no double tax burden, since the taxation is different tax entities (partners and corporations).11

3.2 Start and end of tax liability

Especially in the start-up phase of corporations, the beginning of tax liability is of enormous importance.12 A corporation is created from a civil law point of view with the registration in the commercial register.13 In practice, however, usually extensive preparatory measures precede. 14 A distinction is made between 2 phases.15 In the period between the founding decision of the shareholders and the conclusion of a company contract or the adoption of articles of association, the so-called pre-founding company is created. During this period, it is subject to the rules of the BGB.16 “With the notarial conclusion of the company contract, a pre-company is established until registration, the corporation in the founding stage (founder company).“17 The founder company is subject to corporate tax. In contrast, the pre-founder company is taxed like a partnership. As soon as a corporation is deleted from the commercial register, it no longer exists legally. Upon completion of the liquidation of the company assets, the tax liability also ends. During insolvency proceedings or during winding-up, the company’s tax liability remains. The deletion in the commercial register is not decisive.18

3.3. Determination of the corporate tax payable

“In the case of corporations, cooperatives and mutual insurance associations, all income which falls under one of the seven types of income of §§ 13-22 EStG shall be qualified for income from commercial operations” (§ 8 para. 19 These seven types of income include, inter alia, income from agriculture and forestry, income from the sale of the holding and income from the sale of shares in a limited company, § 13 ff. EStG. Thus, the amount of income is calculated exclusively according to § 8 Abs. 2 KStG. The tax balance derived from the trade balance forms the basis for the determination of profit. Off-balance-sheet additions and reductions are then offset against the profit of the tax balance and thus serve as a correction of profit. The statutory provisions of the Income Tax Act are to be applied here.20 Based on the taxable income, the corporate tax is calculated, § 7 para. 1 KStG. The allowances in §§ 24 and 25 KStG do not apply to corporations and therefore cannot be deducted, § 7 para. 2 KStG. The taxable income is determined according to the Income Tax Act, § 8 Abs. 1 KStG. Whereas profits of a corporation are subject to corporate tax, losses lead to a reduction in taxable income and thus also tax levies.21 As the taxable income is generally determined, Figure 4 shows. For example, the annual profit determined in accordance with the trade balance is corrected on the basis of accounting and valuation provisions of the Income Tax Act, which leads to the result of the tax profit. Then you add or subtract off-balance-sheet additions or reductions to get the tax profit. Next, donations and membership fees within the meaning of § 9 Abs. 1 no. 2 KStG deducted. The total amount of income received is then reduced by the loss advances or provisions. Finally, you take the income determined and subtract the possible allowances according to §§ 24 and 25 KStG, which is not possible for corporations.

Figure 5: Calculation of taxable income

Source 5: Jäger, C., Heupel, T., Management Basics, 2020, p.

The income determined is then charged with the corporate tax. The tax rate is 15%, § 23 Abs. 1 KStG. Income tax and corporate law regulations must be observed here. While special corporations may claim exemptions, corporations are not empowered to do so.22 The 15 % determined then constitutes the corporate tax rate. From this, foreign taxes to be deducted are then deducted. The established corporate income tax is reduced by the capital gains tax and the quarterly advance payment of corporate income tax. As a result, you will receive the final payment to be made or the final refund (see Figure 5). In addition to corporate tax, the limited liability company also has to pay a solidarity surcharge of 5.5%.23

Figure 6: Final payment/refund calculation

Source 6: Jäger, C., Heupel, T., Management Basics, 2020, p.

3.4.Determination of business tax

However, a corporation is not obliged to pay corporate tax. The company also has to pay trade tax. Since they are treated as a business regardless of their field of activity.24 The tax profit is used as a starting point for the calculation. The further calculation can be seen in Figure 6.

Figure 7: Determination of business income

Source 7: Jäger, C., Heupel, T., Management Basics, 2020, p.

From the business income determined, 3.5% of the business tax is then determined. If a company has several branches in different municipalities, the trade tax is distributed among the individual municipalities by means of a distribution key.25 This is usually based on the paid wage of the individual permanent establishments, § 29 para. 1 No. 1 GewStG. The lifting rate to be multiplied is determined by the municipality itself, but is at least 200 %, § 16 GewStG.

Figure 8: Determination of the tax liability due

Source 8: Jäger, C., Heupel, T., Management Basics, 2020, p.

4th Conclusion

As you could see in the course of the work, the corporation contributes a lot to the tax revenues of the German state. Both corporation tax, capital gains tax and business tax must be levied by the company. This leads to a significant reduction in profits. Since the principle of separation applies in the case of limited liability companies, the personal taxation of shareholders, unlike other legal forms, is strictly separated from the taxation of the limited liability company. The corporate tax payable is calculated on the basis of the taxable income. This is based on the annual surplus of the trade balance. In addition, there is also the solidarity surcharge, capital gains taxes and business tax. So corporations are exposed to a high tax burden, which leads to huge profit reductions. When choosing the legal form, new founders should therefore always compare the individual legal forms with each other and, above all, also include the tax burdens of the individual forms of company. Even if corporations also bring certain advantages over other legal forms, the annual tax burden must not be neglected.